Employment and Unemployment

Employment and Unemployment

The natural rate of unemployment and full employment
The natural rate of unemployment is the rate of unemployment that exists in regular or non-recessionary economic circumstances. It is the type of unemployment that exists when the economy experiences structural and frictional unemployment but not cyclical unemployment. Knowing the natural rate of unemployment gives policymakers information about the state of the economy and aids in their decision-making concerning economic policies.

When nearly all eligible individuals who are willing to work and actively seek employment have jobs, the economy is said to be in full employment. Theoretically, unemployment occurs at a very low and frequently regarded “natural” rate; any residual unemployment is usually frictional (i.e., transient unemployed between jobs) or structural (i.e., skills mismatches with unfilled positions).

For policymakers, reaching full employment is a crucial objective because it signifies a strong economy in which the majority of people who wish to work can find gainful employment. Higher productivity, more consumer spending, and general economic expansion are frequently the results of it. However, there are differences in the exact definition and measurement of full employment, and it is frequently difficult to achieve because of a variety of economic circumstances and volatility.


Equilibrium unemployment and disequilibrium unemployment

The level of unemployment known as equilibrium unemployment is what happens when the labour market is in balance, meaning that the number of open positions equals the number of job seekers. In this scenario, structural and frictional unemployment are both regarded as “natural” forms of unemployment. QE to Q1 in Figure 1 below represents equilibrium unemployment. Some people who are part of the labour force (NL in Figure 1 below) do not want to work at the current or equilibrium wage rate. 

Figure 1: Equilibrium unemployment

Graph showing equilibrium unemployment

Conversely, disequilibrium unemployment happens when there is a discrepancy between the labour supply (job seekers) and the labour demand (job opportunities) in the economy. Q1 to Q2 represents disequilibrium unemployment. 

Figure 2: Disequilibrium unemployment


Non-accelerating inflation rate of unemployment (NAIRU)

It is a measure of the unemployment rate at which inflation is neither rising nor falling. To put it simply, it’s the percentage of unemployment that tends to increase inflation and decrease inflation over a certain threshold.

It means that an economy has a natural rate of unemployment that is compatible with steady inflation. Demand for workers rises when labour markets tighten and the real unemployment rate drops below the NAIRU. Wages typically grow as employers compete for a smaller pool of available labour, which can result in higher production costs for companies. Businesses may raise prices to preserve their profit margins, which would boost inflationary pressures.

On the other hand, there is less pressure on the labour market, which slows wage growth, when the actual unemployment rate is higher than the NAIRU. Consumer spending may decline as a result of this circumstance, and companies may decide to cut prices in an effort to increase demand. Consequently, inflation tends to slow down or even reverse.